Deflationary Hurricanes to Hit U.S. and U.K.

British households are now more indebted than those of any other major country
in recorded history, it has emerged.

Families in the UK now owe a record 173pc of their incomes in debts, official
figures have shown. The ratio of debt to income is higher than any other
country in the Group of Seven leading industrialised economies, and is sharply
higher than the 129pc of incomes it was five years ago.

Michael Saunders of Citigroup warned that - at 173pc of household incomes
- the debt burden is higher even than Japan's when it peaked in 1990, before
more than a decade of deflation. Philip Shaw of Investec said: "Although
we take the view that the economy will avoid a recession, our confidence
is ebbing."

Avoid A Recession?

It will be hard for the US and UK to avoid a depression.

What started as a tropical storm called "Subprime" has intensified in magnitude
to engulf Alt-A, HELOCs, credit cards, commercial real estate, municipal bonds,
corporate bonds, and the stock market, just as baby boomers are headed for
retirement.

Barclays Capital has advised clients to batten down the hatches for a worldwide
financial storm, warning that the US Federal Reserve has allowed the inflation
genie out of the bottle and let its credibility fall "below zero".

"We're in a nasty environment," said Tim Bond, the bank's chief equity strategist. "There
is an inflation shock underway. This is going to be very negative for financial
assets. We are going into tortoise mood and are retreating into our shell.
Investors will do well if they can preserve their wealth."

Barclays Capital said in its closely-watched Global Outlook that US headline
inflation would hit 5.5pc by August and the Fed will have to raise interest
rates six times by the end of next year to prevent a wage-spiral. If it hesitates,
the bond markets will take matters into their own hands. "This is the first
test for central banks in 30 years and they have fluffed it. They have zero
credibility, and the Fed is negative if that's possible. It has lost all
credibility," said Mr Bond.

No Wage Price Spiral

Wage price spirals happen when corporations get into bidding wars over employees,
not when they are shoving them out the door by the hundreds of thousands. Mr.
Bond must be reporting from Bizarro World. The odds of a wage price spiral
in the US are essentially zero as credit is drying up and overcapacity is everywhere
you look. Massive
Government and Private Sector Job Cuts Are Coming.

This is not Bizarro World, nor it is 1970.

If Barclays is betting on six interest rates hikes in the US with its own
money it will likely get carted out in a coffin. Property values are crashing,
unemployment is rising, wages are falling, global wage arbitrage is king, and
most importantly Peak
Credit Has Arrived.

It is impossible to get inflation out of that mix. Berananke could cut interest
rates to zero tomorrow and it would not cause inflation, at least as properly
defined: a net expansion of money and credit. Banks are strapped for cash.
They cannot lend. Businesses do not want to borrow. There is overcapacity everywhere.
The Shopping
Center Economic Model Is History.

I struggle to see how anyone can get inflation out of that mix. Last Thursday
when the stock markets were in a freefall, I asked Is
The Inflation Scare Over Yet? Well, I guess it's not.

Fed Has Lost Credibility

However, I will grant Mr. Bond one thing. "The Fed has lost all credibility." I
discussed that idea in Things
That Have Not Yet Happened in response to Bernanke's absurd claim "Danger
of downturn appears to have waned."

Actually, I see another statement from Mr. Bond that I agree with, and it
is an important one: "Inflation is out of control in Asia. Vietnam has already
blown up."

Inflation is indeed out of control in Asia, notably China, India, and Vietnam.
That inflation stems from Asia central bankers printing local currency to buy
US dollars, in an attempt to keep their export machines going.

Bernanke foolishly calls this a savings glut. Printing money to buy dollars
does not constitute savings. It is amazing that a Fed governor does not understand
this simple truth.

Besides, it is virtually impossible to have "too much savings". The construct
does not even exist!

Peak oil, in conjunction with a crack up inflationary boom in China is masking
deflation in the US and pending deflation in the UK. Those focused on rising
energy and food prices are missing the boat.

However, I suspect China is going to slam on the brakes after the Olympics.
The Shanghai Stock Exchange Index sure acts as if something is coming down
the pike.

$SSEC Weekly Chart

Who's In Control?

Ben Bernake at the Fed, Mervyn King at the Bank of England, and Jean-Claude
Trichet at the ECB are not in control of what is about to happen. When it comes
to commodity prices,peak oil and China's willingness to allow its economy to
overheat are going to be the driving forces. Trichet can hike all he wants
and it will not matter much to the price of oil. However, it may crush individual
economies in the EU.

This does not mean hiking is wrong (although it likely is), it simply means
that hiking to rein in gasoline and food prices, two rather inelastic needs,
is beyond silly.

Implications of Peak Credit

When it comes to the collapse in credit, the above Central Banks are powerless
to do a thing about it. This is to be expected now that we are on the backside
of Peak
Credit.

The saturation point has been reached. It took decades but we have finally
arrived. None of the financial engineering jobs that fueled this credit boom
will ever be needed again. SIVs, Conduits, Toggle Bonds, Covenant Lite loans
are all dead for years, more likely decades to come. Add to that liar loans,
Pay Option Arms, insane leverage, and numerous other ridiculous lending arrangements.
And if those things are not coming back, we do not need Wall Street shills
to securitize that garbage and pitch it to unsuspecting suckers.

In addition to financial engineering jobs, there was a boom in commercial
real estate, home depots, remodeling companies, landscaping, furniture, appliances,
plumbing, heating, air conditioning, restaurants, and even things like grass
seed.

There is no source of jobs to replace what has been lost and what will be
lost. Discretionary spending is dead. Boomers about to retire are about to
get religion. Sadly, it's too late. Savings they thought they had in their
house, have now vanished into thin air. It was all a mirage in the first place,
but mountains of credit has been extended on the basis of that mirage. Trillions
of dollars of imagined wealth has gone up in smoke. Trillions of dollars more
are about to.

Deflation Has Set In

It is amusing that in the face of this carnage, many are still screaming inflation,
stagflation, or even hyperinflation simply because food and energy prices are
rising. Deflation is here and now in the US. Deflation is knocking on the door
of the UK and Eurozone. And there is nothing that can be done about it.

Can The Fed Print Its Way Out?

Some will insist that I am wrong, that the Fed can print. Well the Fed can
print, but the Fed cannot spend. In addition, the Fed cannot give money away,
nor would the Fed even if it could. Finally, the Fed cannot force banks to
lend or businesses or consumers to borrow.

Bank credit is contracting with the Fed Funds rate at 2%. Bank credit would
not be going much of anywhere even at 0% in my estimation. The reason is simple:
banks are insolvent!

The Fed is like the powerless man behind the curtain in the Wizard of Oz.
Once peak credit sets in, all the Fed can do is bluff. The notion of a helicopter
drop is pure nonsense.

What About A Crack-Up Boom?

We had a crack-up-boom. What else can you call the financial engineering that
went with SIVs, Conduits, Toggle Bonds, Covenant Lite loans, Pay Option ARMs,
etc., etc? That crack-up-boom is over. And just like every credit boom in history,
the backside, once the credit boom ends is deflation. Previous examples include
Tulip Mania, the South Sea Bubble, John Law Mississippi scheme, the Great Depression,
and the property bust in Japan.

Weimar Germany was not a credit boom, but an example of hyperinflation caused
by massive printing to pay for war reparations. Zimbabwe is another example
of hyperinflation caused by printing.

What About Congress?

Congress, unlike the Fed, can indeed spend money it does not have. They have
already done so with an ill-advised stimulus package. There will indeed be
more stimulus packages just as there was in Japan. However, nothing can match
the sheer number of jobs created in the housing and commercial real estate
booms. And nothing can replace the destruction of wealth that is now taking
place in housing and the equity markets.

Attitudes Lead The Way

It took nearly 80 years for people to get as reckless as they did in 1929.
80 years! Few are still alive that went through the great depression. That
is the nature of the game. People have to forget what a depression is like
to bring about the conditions that cause them. And they did. And they made
the same mistakes over again, except larger.

The madness of crowds, however, can only go so far. A significant reversal
is now underway. The secular peak in consumption has been reached. A reversal
in attitudes towards consumption started with houses, but it’s spreading
to cars, boats, and even Starbucks coffee. It will take a long time for attitudes
to get back to equilibrium. And attitudes, like pendulums, will not stop at
equilibrium once they get there.

The odds of a significant bout of inflation now are about the same as they
were in 1929. Next to none. History is about to repeat.